Beijing is behaving like Milton Friedman's fool in the shower

Milton Friedman described this situation as 'the fool in the shower'. A fool takes a shower. Finding the water too cold, he turns up the hot tap. Naturally, the hot water takes a while to arrive. But the fool, being foolish, doesn't wait, and turns the hot tap even higher. Not surprisingly, he overdoes it, and gets a painful scalding.

In his haste to avoid getting boiled, he quickly turns the hot water down and opens up the cold tap. Alas, he overreacts, leaving himself shivering under a jet of freezing water. Once again he rushes to turn the cold down and the hot water up, repeating the whole unpleasant cycle.

Friedman used the analogy of the showering fool to illustrate what happens when central banks or governments overreact to swings in the economic cycle and loosen monetary and fiscal policies too far too fast, without waiting to gauge the impact of their initial actions. In response, the economy overheats, prompting the authorities into an excessive tightening.

The upshot is an overly volatile cycle which discourages sound long-term planning and ultimately damages growth.

Back in late 2007, commentators wondered whether US Federal Reserve chairman Ben Bernanke was acting like the showering fool by cutting interest rates aggressively in response to the developing credit crunch.

Today, it is Chinese policymakers who are being accused of foolishness in their own economic shower. They overdid things with last year's stimulus efforts, allowing a massive credit expansion equal to almost 30 per cent of gross domestic product. And now they are responding to the resultant overheating by hosing the economy down with the equivalent of a blast of icy water.